7 Reasons to be Bearish on the Chinese Yuan

Chinese yuan bears have been caught short as the currency strengthened about 1.9% against the U.S. dollar since the end of last year.

Expectations for where the offshore Chinese yuan – or CNH – will be in a year’s time against the greenback have also been revised upwards to reflect a stronger yuan after Beijing introduced a counter-cyclical adjustment factor to its fixing mechanism for the daily yuan-dollar exchange rate. The average forecast has fallen from CNY7.30 per dollar at the beginning of the year to a current level of slightly below CNY7.

However, Rabobank strategist Michael Every argues there are still many reasons to be bearish on the yuan.

1. Déjà vu

After all, we have been here before – a lot. We have seen five bouts of forward CNH depreciation, and this is the fourth time that such expectations have been sharply reversed by subsequent PBOC market intervention: yet each time, after a pause, they rapidly build again - and this rally is now long in the tooth. Will this time round prove any different? The fundamentals suggest it won’t.

2. Slowdown

As we have stressed repeatedly for some time, economic growth in China is now almost totally debt dependent, and those debt dynamics say that the economy is going to slow sharply into H2 2017 and H1 2018.

3. Red-lights

In trying to deal with its major debt problems -and they are truly spectacular- in particular, by now cracking down on excesses in the shadow banking system, China is exposing its financial system to significant stress.

4. Debt

On the borrowing side, the argument -and the math- are crystal clear. Let’s assume that China has a debt-to-GDP ratio of 300%, including the central and local governments, households, firms, and banks. Actually, we believe it is higher than that when we factor in off-book lending, etc., but it’s a round number. Let’s also guesstimate an indicative average interest rate on that debt burden knowing that:

(i) The weighted average household borrowing rate was 4.6% as of Q1;

(ii) The 10-year government bond yield was around 3.25%;

(iii) The average corporate borrowing rate was 4.35%; and

(iv) The 3-month SHIBOR rate is now 4.75%. Putting those rates together and weighting them gives us a rough total borrowing rate of around 4.3%.

Importantly, with debt-to-GDP of 300% that means China needs to generate 3 x 4.3% = 12.9% in nominal GDP growth simply to cover the interest on its debt without any principle repayment.

5. The PBOC

Meanwhile, on the funding cost side the PBOC can help and is helping. Actually, the PBOC is increasingly finding itself playing the supportive liquidity role that other central banks already undertake. Indeed, after the local government finance vehicle bailout of a few years ago, it is now having to step up again with a variety of acronym driven liquidity injections and lending facilities to try to tamper down the spike in inter-bank borrowing costs – to relatively limited effect so far, it must be said. If the recent experiences of the Fed, BoJ, ECB, BoE, and others are repeated to even some degree in China –and given its housing bubble and debt levels, that is very likely- then the PBOC’s balance sheet is set to expand rapidly, even accounting for a possible drain in FX reserve assets. In fact, looking further out it becomes extremely hard to see how this balance-sheet expansion will not occur; and recall that everywhere else that this has happened, the logical response has been a sharp fall in the value of that country’s currency given the simple supply vs. demand impact.

6. The Fed

Of course, China needs low/ lower interest rates: most countries do. But it can’t have them without consequences right now. Things are made infinitely harder for Beijing by the actions of the US Federal reserve, which continues to hike rates. Indeed, at 1.25% Fed Funds are now just 25bp lower than the official benchmark PBOC rate of 1.50%.

7. CFETS

Furthermore, consider that even as the market eye remains on USD/CNY, the broader CNY basket (or CFETS) as seen a steady depreciation. Indeed, on this total basis CNY is down from 95.7 to 92.6 since the start of the year, or more than a 3.0% decline, and a near 6% drop since late-2015. In short, CNY is ‘strong and stable’ – against a weak and unstable USD; against most everything else it is still quite happy to try to eke out a little extra competitiveness where it can.

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7 Reasons to be Bearish on the Chinese Yuan

Chinese yuan bears have been caught short as the currency strengthened about 1.

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